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Managerial

Accounting
(MBA-511)
Topics to Cover
• Managerial vs Financial Accounting
• Planning, Directing, and Controlling
• Manufacturing Costs
• Cost Behavior
• Product Costing Approaches
• Cost-volume-profit Analysis
• Product Costing Systems
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Managerial Accounting
Defn…
Defn…..Managerial accounting encompasses
techniques and processes that are intended to
provide financial and non-financial
information to people within an organization
to make better decisions and thereby
improve the efficiency and effectiveness
of existing operations

12/10/2018 Teshale.G 3
Managerial Financial
Factor
Accounting Accounting
Communicate financial
Purpose Decision making
position to outsiders

Primary Users Internal managers External users

Focus/Emphasis Future-oriented Past-oriented

Do not have to follow GAAP; GAAP compliant;


Rules
cost vs. benefit CPA audited

Ultra current to very long Historical monthly, quarterly


Time Span
time horizons reports

Designed to influence Indirect effects on


Behavioral Issues
employee behavior employee behavior
12/10/2018 Teshale.G 4
Managing Resources, Activities,
and People
An organization . . . Decision
Making

Controlling
Acquires Resources
Organized set
of activities

Directing
Planning
Hires People

12/10/2018 Teshale.G 5
How Managerial Accounting Adds
Value to the Organization
• Providing information for decision making and
planning.(Budgeting)
• Assisting managers in directing and controlling
activities .eg.Daily sales &Performance report
• Motivating managers and other employees towards
organization’s goals.
• Measuring performance managers, and employees.
• Assessing the organization’s competitive position.

12/10/2018 Teshale.G 6
Manufacturing Costs

Direct Direct Manufacturing


Materials Labor Overhead

The Product

12/10/2018 Teshale.G 7
Direct Materials
Raw materials that become an
integral part of the product and
that can be conveniently traced
directly to it.

Example: A radio/CD player installed in an


automobile

12/10/2018 Teshale.G 8
Direct Labor
Those labor costs that can be
easily traced to individual
units of product.(touch labor)

Example: Wages paid to automobile assembly line workers &


machine operators

12/10/2018 Teshale.G 9
Manufacturing Overhead
Manufacturing costs that cannot be traced
directly to specific units produced.

Examples: Indirect materials ,indirect labor and others


(maintenance and repairs, heat & light, property tax, insurance and
Depreciation)

Materials used to support


I

Wages paid to employees


the production process. who are not directly
Examples: lubricants and involved in production
cleaning supplies used in the work.
automobile assembly plant. Examples: maintenance
workers, janitors and
security guards.

12/10/2018 Teshale.G 10
Manufacturing Costs …

Direct Direct Manufacturing


Materials Labor Overhead

Prime Conversion
Cost Cost

12/10/2018 Teshale.G 11
Nonmanufacturing Costs

Administrative
Selling
Costs
Costs

Costs necessary to
All executive,
secure the order and
organizational, and
deliver the product.
-Advertising clerical costs.
-shipping -Secretarial
-Sales travel
-sales commission -Public relation
-Sales salaries
12/10/2018- Teshale.G 12
Product Costs Versus Period Costs
Product costs include Period costs include all
direct materials, direct selling costs and
labor, and manufacturing administrative costs.
overhead.

Inventory Cost of Good Sold Expense

Sale

Balance Income Income


Sheet Statement Statement
12/10/2018 Teshale.G 13
Comparing Merchandising and
Manufacturing Companies
Merchandisers . . . Manufacturers . . .
Buy finished goods. Buy raw materials.
Sell finished goods. Produce and sell
finished goods.

Shoa Mart

12/10/2018 Teshale.G 14
Balance Sheet
Merchandiser Manufacturer
Current assets Current Assets
Cash  Cash
 Receivables
Receivables
 Inventories
Merchandise • Raw Materials
Inventory • Work in Process
• Finished Goods

12/10/2018 Teshale.G 15
Balance Sheet
Merchandiser Manufacturer
Current assets Current Assets
 Cash  Cash
Materials waiting to
 Receivables  Receivables
be processed.
 Merchandise Inventory  Inventories
Partially complete
products – some • Raw Materials
material, labor, or • Work in Process
overhead has been • Finished Goods
added.
Completed products
awaiting sale.

12/10/2018 Teshale.G 16
The Income Statement
Cost of goods sold for manufacturers differs
only slightly from cost of goods sold for
merchandisers.
Manufacturing Company
Merchandising Company
Cost of goods sold:
Cost of goods sold: Beg. finished
Beg. merchandise goods inv. $ 14,200
inventory $ 14,200 + Cost of goods
+ Purchases 234,150 manufactured 234,150
Goods available Goods available
for sale $ 248,350 for sale $ 248,350
- Ending - Ending
merchandise finished goods
inventory (12,100) inventory (12,100)
= Cost of goods = Cost of goods
12/10/2018 Teshale.G sold $ 236,250 17
sold $ 236,250
Basic Equation for Inventory
Accounts

Withdrawals
Beginning Additions Ending
balance + to inventory = balance + from
inventory

12/10/2018 Teshale.G 18
Basic Equation for Inventory Accounts
The computation of Cost of Goods
Sold relies on this basic equation
for inventory accounts. The logic
underlying this equation applies to
any inventory account. Any units
that are in inventory at the
beginning of the period appear as
the beginning balance.
12/10/2018 Teshale.G 19
Basic Equation for Inventory Accounts
During the period, additions are made to
the inventory through purchases or other
means. The sum of the beginning
balance and the additions to the account
is the total amount of inventory available.
During the period, withdrawals are made
from inventory. The ending balance is
whatever is left at the end of the period
after the withdrawals.
12/10/2018 Teshale.G 20
Schedule of Cost of Goods
Manufactured
Calculates the cost of raw
material, direct labor, and
manufacturing overhead
used in production.

Calculates the manufacturing


costs associated with goods
that were finished during the
period.
12/10/2018 Teshale.G 21
Product Cost Flows
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials


materials inventory
+ Raw materials
purchased
= Raw materials
available for use
in production
– Ending raw materials
inventory
= Raw materials used
As items are removed from raw
in production materials inventory and placed into
the production process, they are
called direct materials.
12/10/2018 Teshale.G 22
Product Cost Flows
Manufacturing Work
Raw Materials Costs In Process
Conversion
Beginning raw Direct materials
materials inventory + Direct labor
costs are costs
+ Raw materials + Mfg. overhead incurred to
purchased = Total manufacturing convert the
= Raw materials costs
direct material
available for use
in production into a finished
– Ending raw materials product.
inventory
= Raw materials used
in production

12/10/2018 Teshale.G 23
Product Cost Flows
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Beginning work in


materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials
inventory All manufacturing costs incurred
= Raw materials used during the period are added to the
in production
beginning balance of work in
process.

12/10/2018 Teshale.G 24
Product Cost Flows
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Beginning work in


materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials – Ending work in
inventory
Costs associated with the goods that process inventory
= Raw materials used = Cost of goods
areincompleted
production
during the period are manufactured
transferred to finished goods
inventory.
12/10/2018 Teshale.G 25
Product Cost Flows
Work
In Process Finished Goods

Beginning work in Beginning finished


process inventory goods inventory
+ Manufacturing costs + Cost of goods
for the period manufactured
= Total work in process = Cost of goods
for the period available for sale
– Ending work in - Ending finished
process inventory goods inventory
= Cost of goods Cost of goods
manufactured sold

12/10/2018 Teshale.G 26
Manufacturing Cost Flows
Balance Sheet Income
Costs Inventories Statement
Expenses
Material Purchases Raw Materials

Direct Labor Work in


Process
Manufacturing
Overhead Cost of
Finished
Goods
Goods
Sold

Selling and Period Costs Selling and


Administrative Administrative
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Cost behavior How a cost will react to
changes in the level of
activity within the
relevant range.
– Total variable costs
change when activity
changes.
– Total fixed costs remain
unchanged when activity
changes.

12/10/2018 Teshale.G 28
Variable Cost
Your total texting bill is based on how many
texts you send.
Total Texting Bill

Number of Texts Sent


12/10/2018 Teshale.G 29
Variable Cost Per Unit
The cost per text sent is constant at 5 cents
per text.

Cost Per Text Sent


Number of Texts Sent
12/10/2018 Teshale.G 30
Fixed Cost
Your monthly contract fee for your cell phone is
fixed for the number of monthly minutes in your
contract. The monthly contract fee does not
change based on the number of calls you make.
Monthly Cell Phone
Contract Fee

Number of Minutes Used


12/10/2018 Within Monthly Plan
Teshale.G 31
Fixed Cost Per Unit
Within the monthly contract allotment, the average
fixed cost per cell phone call made decreases as more
calls are made.

Monthly Cell Phone


Contract Fee
Number of Minutes Used
12/10/2018 Teshale.G Within Monthly Plan
32
Behavior of Cost (within the relevant range)
Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Fixed cost per unit goes
the same even when the down as activity level goes up.
12/10/2018
activity level changes.
Teshale.G 33
Exercise-1
ABC Company manufactures furniture, including tables.
Selected costs are given below:
1. The tables are made of wood that costs Br.100 per
table.
2. The tables are made by workers, at a wage cost of Br.
40 per table.
3. Workers making the tables are supervised by a factory
supervisor who is paid Br.38,000 per year.
4. Electrical costs are Br. 2 per machine-hour. Four
machine-hours are required to produce a table.
5. Machine cleaning materials cost total Br. 15,000 per
year.
6. Compensation to factory cleaners total Br. 30,000 per
year.
12/10/2018 Teshale.G 34
7. Depreciation on the machines used to make the
tables totals Br. 10,000 per year.
8. The salary of the manager of ABC Company is Br.
100,000 per year.
9. ABC Company spends Br. 5,000 per year to advertise its
products.
10.Salespersons are paid a commission of Br. 30 for each
table sold.
11.Salary of company guards total Br. 14,000 per year.

• Required: classify the costs as DM, DL, MOH, direct,


indirect, fixed, variable, prime, conversion, selling,
administrative, product and period (use a table similar
to the one provided on the next slide)
12/10/2018 Teshale.G 35
Exercise-1 …
Cost classification table

Cost DM DL MOH Dir Indi Fix Var Prim Conv Sell Admi Product Period

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CVP Analysis
All managers want to know how profits will change
as the units sold of a product or service change.

Accountants often perform CVP analysis to plan


future levels of operating activity and provide
information about:
Which products or services to emphasis
The volume of sales needed to achieve a targeted level
of profit
The amount of revenue required to avoid losses
Whether to increase fixed costs
What profit can be expected on a given sales volume

12/10/2018 Teshale.G 37
Cost-Volume-Profit (CVP) Analysis
 A model relating revenues (R), costs (C) and volume
(V) and their effects on company profit
 Assumptions
 Changes in R and C are due to change in V
 Linear relationship over the relevant range
 Cost can be divided into variable and fixed
 Unit selling price, VC and FC are known/constant
Basic question – how many units should be sold to
 Cover all costs (VC+FC) – breakeven point
 R=VC + FC
 Earn target profit
 R=VC + FC + target profit
12/10/2018 Teshale.G 38
12/10/2018 Teshale.G 38
CVP Analysis
The CVP income statement is for internal use only,
classifies costs and expenses as fixed or variable,
reports a contribution margin in the body of the
statement.

Contribution margin – amount of revenue


remaining after deducting all variable
costs
The contribution margin is often reported as a total
amount and on a per unit basis.

12/10/2018
12/10/2018 Teshale.G 39
Cost-Volume-Profit Graph
Cost-Volume-Profit Graph
450,000

400,000

350,000

300,000
Dollars

250,000

200,000

150,000

100,000
Fixed expenses
50,000

100 200 300 400 500 600 700 800


Units

7-40
12/10/2018 Teshale.G
Cost-Volume-Profit Graph
Cost-Volume-Profit Graph
450,000

400,000

350,000

300,000
Dollars

250,000

200,000

150,000

100,000
Fixed expenses
50,000

100 200 300 400 500 600 700 800


Units

7-41
12/10/2018 Teshale.G
Cost-Volume-Profit Graph
Cost-Volume-Profit Graph
450,000

400,000

350,000

300,000
Dollars

250,000

200,000

150,000

100,000
Fixed expenses
50,000

100 200 300 400 500 600 700 800


Units

7-42
12/10/2018 Teshale.G
Cost-Volume-Profit Graph
Cost-Volume-Profit Graph
450,000

400,000

350,000

300,000
Dollars

250,000

200,000

150,000
Fixed expenses
100,000

50,000

100 200 300 400 500 600 700 800


Units

7-43
12/10/2018 Teshale.G
Cost-Volume-Profit Graph
450,000

400,000

350,000
Break-even
300,000
point
Dollars

250,000

200,000

150,000

100,000
Fixed expenses
50,000

100 200 300 400 500 600 700 800


Units

7-44
12/10/2018 Teshale.G
Cost-Volume-Profit Graph
Profit-Volume Graph
Some managers like the profit-volume
graph because it focuses on profits and volume.

100,000

80,000

60,000
Break-even
40,000 point
20,000
Profit

0 `

(20,000) 100 200 300 400 500 600 700


Units
(40,000)

(60,000)

7-45
12/10/2018 Teshale.G
Exercise
ABC Printers provides photocopy services to its
customers. The unit variable cost and selling price are Br
0.20 and Br 0.50, respectively, while monthly fixed costs
total Br. 1,500.
Required:
a) How many pages must ABC copy in a month to breakeven?
b) How many pages must ABC copy to earn Br. 900 profit per month?
c) How much sales revenue should ABC earn in a month to
breakeven?
d) How many pages must ABC copy to earn Br. 700 profit after 30%
income tax?
e) If price per page is increased to Br. 75, how many pages must ABC
copy in a month to breakeven?

12/10/2018 Teshale.G 46
Break-even Analysis – Single Product
A. Break-even volume = Total fixed costs
(units) Unit contribution margin

B. Break-even volume Total fixed costs


=
(sales dollars) Contribution margin ratio
C. Unit contribution
margin = Unit selling price – unit variable cost

D. Unit contribution Unit contribution margin


margin ratio = Unit selling price

12/10/2018 Teshale.G 47
Break-even Analysis …
E. Target volume Total fixed costs + Target profit
=
(units) Unit contribution margin

F. Target volume Total fixed costs + Target profit


=
(sales dollars) Contribution margin ratio
G. Target volume Total fixed costs + After tax target profit
=
(sales dollars) Contribution margin ratio
H. After tax target Target profit
=
profit 1-tax rate

12/10/2018 Teshale.G 48
Break-even Analysis – Multiple Products
A. Break-even volume = Total fixed costs
(units) Weighted average unit contribution margin
B. Break-even volume= Total fixed costs
(sales dollars) Weighted average contribution margin ratio

C. Weighted average unit


CM =  M UCM i i

D. Weighted average unit Weighted average unit contribution margin


CM ratio = Weighted average unit selling price

E. Weighted average unit


selling price =  M USP i i

12/10/2018 Teshale.G 49
Break-even Analysis …
F. Target volume Total fixed costs + Target profit
(units) =
Weighted average unit contribution margin

G. Target volume Total fixed costs + Target profit


=
(sales dollars) Weighted average unit contribution margin ratio

H. Target volume Total fixed costs + After tax target profit


=
(sales dollars) Weighted average unit contribution margin ratio

12/10/2018 Teshale.G 50
CVP Analysis with Multiple Products
For a company with more than one product,
sales mix is the relative combination in which
a company’s products are sold.
Different products have different selling
prices, cost structures, and contribution
margins.
Let’s assume ABC company sells X &Y Product and
see how we deal with break-even analysis.
7-51
12/10/2018 Teshale.G
CVP Analysis with Multiple Products
ABC Co.provides us with the following
information:
Unit Unit Number
Selling Variable Contribution of
Description Price Cost Margin Product
X $ 500 $ 300 $ 200 500
Y 1,000 450 550 300
Total sold 800
Description No.of Pdt % of Total
X 500 62.5% (500 ÷ 800)
Y 300 37.5% (300 ÷ 800)
Total sold 800 100.0%
7-52
12/10/2018 Teshale.G
CVP Analysis with Multiple Products

Weighted-average unit contribution margin

Contribution Weighted
Description Margin % of Total Contribution
X $ 200 62.5% $ 125.00
Y 550 37.5% 206.25
Weighted-average contribution margin $ 331.25

$200 × 62.5%

$550 × 37.5%
7-53
12/10/2018 Teshale.G
CVP Analysis with Multiple Products

Break-even point
Break-even Fixed Cost
=
point Weighted-average unit contribution margin

Break-even $170,000
=
point $331.25

Break-even
= 514 combined unit sales
point

7-54
12/10/2018 Teshale.G
CVP Analysis with Multiple Products

Break-even point Indivi


Descipt BE % of dual
ion Sales Total Sales
X 514 62.5% 321
Y 514 37.5% 193
T. units
7-55
12/10/2018 Teshale.G
514
Exercise 5
Suppose that Leadstar developed three different
products: a small bike for children and youths, a road bike,
and a mountain bike. Total fixed costs for the company are
Br 5,800. Forecasted sales volumes, selling price per unit
and variable cost per unit are as follows:

Youth Road Mtn Total


Forecasted Sales volume 40 20 40 100
Expected sales mix 40% 20% 40% 100%
Selling price per unit Br 200 Br 100 Br 150
Variable Cost Per Unit Br 120 Br 70 Br 100
Instruction: Compute the required number of units and revenue at the break-even
point, assume that no income tax.

12/10/2018 Teshale.G 56
Exercise-6
In addition to photocopying services, ABC Printers provides
secretarial and printing services. The unit variable cost and selling
price are Br 0.75 & Br 1.00, for secretarial, respectively, and Br 0.25
& Br 0.75 for printing, respectively. Its monthly fixed costs for all
services total Br 3,000. The company sells printing, photocopying
and secretarial services in the ratio of 2:5:3.
Required:
a) How many pages must ABC print/copy/write in a month to breakeven?
b) How many pages must ABC print/copy/write to earn Br. 900 profit per
month?
c) How much sales revenue should ABC earn in a month to breakeven?
d) How many pages must ABC print/copy/write to earn Br.700 profit after
30% income tax?
e) If sales mix is changed to 4:4:2, how many pages must ABC
print/copy/write in a month to breakeven? (sensitivity analysis)

12/10/2018 Teshale.G 57
Product Costing Systems
 Concepts
 Cost objects – anything (e.g. product, customer) for which
measurement of cost is needed.
 Direct costs – can be directly traced to a cost object.
 Indirect costs – can be allocated rather than traced to a cost
object.
 Cost assignment – systematic/rational process of tracing or
allocating costs to cost objects.
 Cost driver – factor/reason (e.g. volume of activity) for
incurrence of cost.
 Activity cost pools – an aggregate of all costs needed to
perform an activity (see activity-based costing).

12/10/2018 Teshale.G 58
Assigning Costs to Cost
Objects
Direct costs Indirect costs
• Costs that can be • Costs that cannot be
easily and conveniently easily and conveniently
traced to a unit of traced to a unit of
product or other cost product or other cost
object. object.
• Examples: direct • Example:
material and direct manufacturing
labor overhead

12/10/2018 Teshale.G 59
McGraw-Hill/Irwin
Cost Assignment

Cost Assignment

Direct Cost Tracing


Costs

Cost
Object
Indirect
Cost Allocation
Costs

12/10/2018 Teshale.G 60
Job Order Vs. Process Costing

Job-costing Process-costing
system system

Applicable to distinct units of a Masses of identical or


product or service e.g. custom- similar units of a product or
made machines, houses, service e.g. food and
furniture, etc. chemical processing

12/10/2018 Teshale.G 61
Job Order Costing – Cost Flow
Direct Materials, Direct Labor &
Manufacturing overhead costs

Job-A Job-B

Work in process Work in process

Finished Goods Cost of Goods Sold

12/10/2018 Teshale.G 62
Job Order Costing – Steps
1 – Identify cost object ( jobs)
2 – Identify direct costs and trace them to each job
3 – Identify cost-allocation bases (cost driver/s)
4 – Identify and collect indirect costs
5 – Determine indirect cost unit (pre-determine MOH rate)
Indirect cost unit = total indirect cost/total quantity of cost allocation base
7 – Determine total indirect cost allocated to each job
allocated cost = total quantity of cost allocation base for a job x unit indirect cost

8 – Determine total cost of each job = DM + DL + allocated MOH

12/10/2018 Teshale.G 63
Source Documents

Job cost record

Materials requisition record

Labor time record


12/10/2018 Teshale.G 4 - 64
General Approach to Job Costing
A manufacturing company is planning to sell
a batch of 25 Office furniture (Job No. 650) to a
retailer for $114,800.
Step 1:
The cost object is Job No. 650.
Step 2:
Direct costs are:
Direct materials = $50,000
Direct manufacturing labor = $19,000
12/10/2018 Teshale.G 4 - 65
Continued,
Step 3: 2,480 machine-hours were used for all
jobs. The cost allocation base is machine-hours.
Job 650 used 500 machine-hours

Step 4: Manufacturing overhead costs were


$65,100.
 Step 5: Actual indirect cost rate is
$65,100 ÷ 2,480 = $26.25 per machine-hour.

AMOHR = Actual annual manufacturing overhead costs


Actual annual quantity of the cost-allocation base

12/10/2018 Teshale.G 66
Con’t…
Step 6:Manaufucturing Overhead Cost =
$26.25 per machine-hour × 500 hours = $13,125

Step 7: Total Manufacturing Cost


Direct materials $50,000
Direct labor 19,000
Factory overhead 13,125
Total $82,125

12/10/2018 Teshale.G 67
Con’t…..
What is the gross margin of this job?

Revenues $114,800
Cost of goods sold 82,125
Gross margin $ 32,675
What is the gross margin percentage?

$32,675 ÷ $114,800 = 28.5%

12/10/2018 Teshale.G 4 - 68
Actual Costing vs Normal Costing
Actual costing is a system that uses actual
costs to determine the cost of individual jobs.
It allocates indirect costs based on the actual
indirect-cost rate(s) times the actual quantity of
the cost-allocation base(s).
Normal costing is a method that allocates
indirect costs based on the budgeted
indirect-cost rate(s) times the actual
quantity of the cost allocation base(s).

12/10/2018 Teshale.G 69
Normal Costing
Assume that the manufacturing company budgets
$60,000 for total manufacturing overhead costs
and 2,400 machine-hours.
What is the budgeted indirect-cost rate?
$60,000 ÷ 2,400 = $25 per hour
How much indirect cost was allocated to Job 650?
500 machine-hours × $25 = $12,500

What is the cost of Job 650 under normal costing?


Direct materials $50,000
Direct labor 19,000
Factory overhead 12,500
Total $81,500

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Account for end-of-period under allocated or over
allocated indirect costs using alternative methods.

 over-applied – when applied MOH > actual MOH


 under-applied – when applied MOH < actual MOH
 disposing under-/over-applied MOH Costs– Two
approaches:
1. charging it to cost of goods sold
2. allocating it to work in process, finished
goods and cost of goods sold in proportion to
applied MOH

12/10/2018 Teshale.G 71
12/10/2018 Teshale.G 71
Modern Management of
Costs and Quality
• KAIZEN COSTING
• Lean Manufacturing
• Just in Time Inventory
• Total Quality Management
• Six Sigma

12/10/2018 Teshale.G 72
Kaizen Costing
• Process of cost reduction during the
manufacturing phase of an existing product.
• Kaizen means continuous and gradual
development by small betterment activities
rather than large or radical improvement made
through innovation or large investments in
technology.
• The idea is that improvement is the goal and
responsibility from CEO to laborers.
12/10/2018 Teshale.G 73
How are Kaizen Costing Goals Met?
• The continual and relentless reduction of non-
value-added activities and costs, the elimination
of waste, and improvements in manufacturing
cycle time all contribute to the effort.
• In addition, the improvement suggestions and
kaizen efforts of all employees are taken
seriously and implemented when appropriate.
• The result is a continually more efficient and
cost-effective production process.
12/10/2018 Teshale.G 74
Lean Manufacturing
• Arose in Toyota Japan as the Toyota Production
System.
• Replacing complexity with simplicity
• A philosophy, a way of thinking
• A process of continuous improvement
• Emphasis on minimising inventory
• Focuses on eliminating waste, that is anything
that adds cost without adding value
• Often a pragmatic choice of techniques is used
12/10/2018 Teshale.G 75
Lean Manufacturing goals

Waller, D.L.,,1999,”Operations Management: A Supply Chain Approach”,


(Thompson, London)
12/10/2018 Teshale.G 76
Just-in-Time Manufacturing
“In the broad sense, an approach to achieving
excellence in a manufacturing company based
upon the continuing elimination of waste (waste
being considered as those things which do not
add value to the product). In the narrow sense,
JIT refers to the movement of material at the
necessary time. The implication is that each
operation is closely synchronised with
subsequent ones to make that possible”.
JIT became part of Lean Manufacturing after the publication of
Womack’s Machine that Changed the World in 1991
12/10/2018 Teshale.G 77
Total Quality Management
What is TQM?
TQM is the integration of all functions
and processes within an organization in
order to achieve continuous
improvement of the quality of goods
and services. The goal is customer
satisfaction.
12/10/2018 Teshale.G 78
System
MANAGEMENT
OF PROCESS
QUALITY
CUSTOMER
FOCUS
Driver HUMAN AND
RESOURCE SATISFACTION
DEVELOPMENT
SENIOR
AND
EXECUTIVE
LEADERSHIP MANAGEMENT

STRATEGIC QUALITY
QUALITY AND
PLANNING OPERATIONAL
RESULTS
INFORMATION
AND ANALYSIS

12/10/2018
System Approach
Teshale.G
for TQM 79
Six Sigma
"Delivering Tomorrow's
Performance Today"
What is Sigma ?
• A term (Greek) used in statistics to
represent standard deviation from mean
value, an indicator of the degree of
variation in a set of a process.
• Sigma measures how far a given process
deviates from perfection. Higher sigma
implies poorer performance.

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Six Sigma?
• Why do we call Six Sigma as Six
Sigma and not Four or Five Sigma
or Eight Alpha (another Greek
symbol)?
• Sigma is a statistical term that
measures process deviation from
process mean or target.
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Six Sigma?
• Mean is also referred to as average
in common language.
• The figure six was arrived at
statistically by looking at the
current average maturity of most
business enterprises.

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Six Sigma?
• A statistical concept that measures a
process in terms of defects – at the
six sigma level there are 3.4 defects
per million opportunities.

12/10/2018 But, it is much


Teshale.G more! 84
Process Costing – Cost Flow
Direct Materials, Direct Labor
Indirect Manufacturing Costs

Department-A Department-B

Work in process

Finished Goods Cost of Goods Sold

12/10/2018 Teshale.G 85
Equivalent Units
A manufacturing firm typically has partially
completed units (work-in-process) at the end of an
accounting period.
Under the job costing system, these partially
completed units are not difficult to handle because
job costs are available on job cost sheets

With both complete and partially complete units,


Managers need a way to measure the proper amount
of production work performed during a period. An
equivalent unit is the measure commonly used.
12/10/2018 Teshale.G 86
Equivalent Units
In a process costing system, however, product costs for
partially completed units are not readily available.

Because the focus in cost accounting has shifted from jobs to


processes or departments, the interest is in the unit cost of
performing a certain process for a given period.

Equivalent units are not the same as physical units. For


example, suppose in a given month a chemical company had
in process 30,000 gallons of a chemical, of which 20,000
gallons were complete at the end of the month but the
remaining 10,000 gallons were only 50 percent complete.

The equivalent units would be 25,000 gallons [20,000+


(10,000
12/10/2018 *50%)]. Teshale.G 87
Process costing – steps
1 – Summarize flow of physical units of output
 work in process – beginning
 currently started units

2 – Compute output in terms of equivalent units

3– Compute equivalent unit costs

4 – Summarize total costs to account for classified into material,


labor and overhead further classified into
 work in process – beginning
 currently added costs

5– Assign total costs to units completed and to units in process


Teshale.G
12/10/2018 88
Process costing
Two methods used to prepare the departmental
production cost report
weighted-average method and
the first-in, first-out (FIFO) method.
The weighted-average method includes all costs in
calculating the unit cost, including both costs incurred
during the current period and costs incurred in the prior
period that are shown as the beginning work-in-process
inventory of the current period.

12/10/2018 Teshale.G 89
Process costing

The FIFO method includes in calculating the


unit cost only costs incurred and work performed
during the current period.

FIFO considers the beginning inventory as a batch


of goods separate from the goods started and
completed within the period.

 FIFO assumes that the first work done is to


complete the beginning work-in-process inventory.
12/10/2018 Teshale.G 90
Weighted-average method
To illustrate these two process costing methods,
assume that DH Company has two production
departments, molding and finishing.
 The molding department places a direct material
(plastic vinyl) into production at the beginning of the
process.
Direct labor and factory overhead costs are incurred
gradually throughout the process with different
proportions.
Use the five-step procedure to assign DM, DL, and
FOH costs to the cost object, the molding department
for the month of June/2015.
12/10/2018 Teshale.G 91
Basic Data For Dh Company: Molding Dept
Work-in-process inventory, June 1/15 …………………….…..10,000 units
Direct materials: 100 percent complete ………..$10,000
Direct labor: 30 percent complete ……………… 1,060
Factory overhead: 40 percent complete ………….1,620
Beginning work-in-process inventory ……………$12,680
Units started during June. ………………………………………...40,000 units
Units completed during June and transferred out of the molding department…44,000 units
Work-in-process inventory, June 30…………………………….. .6,000 units
Direct materials: 100 percent complete
Direct labor: 50 percent complete
Factory overhead: 60 percent complete
Costs added during June
Direct materials ………………………………...$ 44,000
Direct labor ………………………………………22,440
Factory overhead ………………………………43,600
Total costs added during June …………………………$110,040

12/10/2018 Teshale.G 92
Step 1: Analyze the Physical Flow of Units—
Molding Department

Input Physical Units


Work-in-process inventory, June 1…….. 10,000
Units started during June …………………40,000
Total units to account for ………………….50,000

Output
Units completed and transferred out during June ..44,000
Work-in-process inventory, June 30………. ……….6,000
Total units accounted for ……………………..……..50,000

12/10/2018 Teshale.G 93
Step 2: EU
EQUIVALENT UNITS
Ph. units Completion% DM DL FOH
WIP June 1 10,000
DM 100%
DL 30%
FOH 40%
Units started 40,000
Units to account for 50,000
Units completed 44,000 100% 44000 44,000 44,000
WIP June 30 6,000
DM 100 6000
DL 50 3,000
FOH 60 3600
Units accounted for 50,000
Total EU
12/10/2018 Teshale.G 50,000 47,000 47,600 94
Step 3: Determine Total
Costs—Molding Department
Beginning WIP inventory
DM $10,000
DL 1,060
FOH 1,620

Total $ 12,680
Costs added during June

DM $44,000
DL 22,400
FOH 43,600
Total cost added 110,040

TC to account for $122,720


12/10/2018 Teshale.G 95
Step 4: Compute Cost per
Equivalent Unit
DM DL FOH TOTAL
Work-in-process, $10,000 $1,060 $ 1,620 $ 12,680
June 1
Costs added during 44,000 22,440 43,600 110,040
June
Total costs to $54,000 $23,500 $45,220 $122,720
account for
Divide by equivalent 50,000 47,000 47,600
units
Equivalent unit costs $ 1.08 $ 0.50 $ 0.95 $ 2.53

12/10/2018 Teshale.G 96
Step 5: Assign TC

Completed and Ending Total


Transferred out WIP
Goods completed and
transferred out (44,000 * $2.53) $111,320 $111,320
Ending work-in-process
Direct materials (6,000 *$1.08) $6,480 6,480

Direct labor (3,000 *$0.50) 1,500 1,500

Factory overhead (3,600 3,420 3,420


*$0.95)
Total costs accounted for $111,320 $11,400 $122,720

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FIFO METHOD
Step 1: for the FIFO method is the same
as the weighted-average method

12/10/2018 Teshale.G 98
Step : 2
FIFO equivalent units of work done during this period
=
Completed and transferred out units
+
Ending work-in-process equivalent units
=
Weighted-average equivalent units
-
Beginning work-in-process equivalent units

12/10/2018 Teshale.G 99
Step 2: EU Alternative
EQUIVALENT UNITS
Inputs Ph. units Completion% DM DL FOH

WIP June 1 10,000


DM 100% 10000
DL 30% 3000
FOH 40% 4000
Units started 40,000
Units to account for 50,000
Outputs
Units completed 44,000 100% 44000 44,000 44,000
WIP June 30 6,000
DM 100 6000
DL 50 3,000
FOH 60 3600
Units accounted for 50,000
Total EU (WAM) 50,000 47,000 47,600

Less: EU in June 1 WIP (10,000) (3,000) (4,000)


EU12/10/2018
(FIFO method) Teshale.G
40,000 44,000 100
43,600
Step 3 & 4
DM DL FOH Total
WIP, June 1 $ 12,680
Costs added during June $44,000 $22,440 $43,600 110,040
Total costs to account for $122,720
Divide by equivalent 40,000 44,000 43,600
units
Equivalent unit costs $ 1.10 $ 0.51 $ 1.00 $ 2.61

12/10/2018 Teshale.G 101


Step 5
Comltd & out Ending Total
WIP
Goods completed and transferred out
Beginning WIP $ 12,680 $ 12,680
Costs added during June
DM 0 0
DL (7,000 *$0.51) 3,570 3,570
FOH(6,000 *$1.00) 6,000 6,000
Total for beginning inventory $ 22,250 $ 22,250
Started and completed (34,000 *$2.61) 88,740 88,740
TC completed and transferred out $110,990 $110,990
Ending work-in-process
DM(6,000 * $1.10) ……………… ………………… $ 6,600 $ 6,600
DL(3,000* $0.51)………………… ………………………… 1,530 1,530
Factory overhead (3,600 *$1.00)… ………… 3,600 3600
Total costs accounted for
12/10/2018 $110,990
Teshale.G $11,730 $122,720102
Exercise-6
Sino-Ethio Home Paints produces exterior latex
paint salable in 1-gallon containers. The company
has two processing departments – Base Fab and
Finishing. White paint, which is used as a base for
all its paints, is mixed from raw ingredients in the
Base Fab. Pigments are added to it and then the
pigmented paint is squirted under pressure into 1-
gallon containers which are labeled and packed for
shipping in the Finishing Department. Operating
data related to the Base Fab Department for April
is provided on the next slide:
12/10/2018 Teshale.G 103
Exercise-6 …

12/10/2018 Teshale.G 104


Exercise-6 …
Required: Determine cost of ending
work in process inventory and units
transferred out of the Base Fab in
April.

12/10/2018 Teshale.G 105


Activity-based Costing – Features
activity – any event, action, transaction or
work sequence that causes a cost to be
incurred in producing a product or
providing a service.
activity levels and cost hierarchy
unit – e.g. output quantity
batch – e.g. machine set-up
product – e.g. product design
customer – e.g. customer order
organization – e.g. building security
12/10/2018 Teshale.G 106
Activity-based Costing – Features
 unique features (compared to process/job-order
costing)
 assigning both manufacturing & non-manufacturing
costs on cause-and-effect basis (only
manufacturing overhead costs are
allocated in the traditional costing
systems)
 expensing costs that do not have any relationship to a
product
 using multiple activity cost pools
 using multiple cost drivers
12/10/2018 Teshale.G
to allocate overhead costs
107
Activity-based costing – steps
1 – Identify and define activities and activity cost pools
2 – Trace costs to activities and cost objects

3 – Assign costs to activity cost pools


4 – Calculate activity rates

5 – Assign costs to cost objects

6 – Prepare management reports

12/10/2018 Teshale.G 108


Overhead Allocation Using Activity
Based Costing (ABC)
Example:
• Suppose a Sony TV set manufacturer produces 14”
and 21” color TV sets.
• They had been using the application of one cost pool
of overhead costs to the two product lines.
• Machine hours had been used to allocate overhead
costs.
• For the next year, the overhead costs are expected to
amount to $300,000 and
• The total machine hours worked were expected to be
30,000 hours.
12/10/2018 Teshale.G 109
Overhead Allocation Using Activity
Based Costing (ABC)
The management accounting division believes that the
traditional approach to assign manufacturing
overhead costs could be misleading.
So the division wants to use Activity Based Costing to
obtain more accurate product costs.
The corporation analyzed the production related
activities and decided that the estimated $300,000 in
manufacturing overhead cost should be grouped into
four activity pools.

12/10/2018 Teshale.G 110


Overhead Allocation Using Activity
Based Costing (ABC)
These are:
1. Setup: preparing machines for production of each
batch.
The estimated total costs of this activity are $100,000
for indirect manufacturing costs.
2.Inspection: This constitutes costs of testing the
products at different stage.
This includes $90,000 for salaries, costs of indirect
materials, indirect labor and depreciation on testing
equipment.

12/10/2018 Teshale.G 111


Overhead Allocation Using Activity
Based Costing (ABC)
3. Packaging: This cost includes estimated total costs of
$65,000 for indirect materials, indirect labor, and
equipment depreciation related to packaging.
4. The last activity is Others: This includes:
– wages,
– property taxes,
– insurance,
– security and all other costs not related to the first
three activities with costs of $45,000.

12/10/2018 Teshale.G 112


Allocation of Overhead (Cont…)
After identifying activity pools, and estimating
activity pool costs.
– then estimate the cost drivers, that are the levels of
each activity performed.
We use this information to determine activity rate.
Activity OHC rate = Activity cost/cost driver
Cost driver can be:
– Number of setups
– Number of inspections
– Packaging hours
– Machine/labour hours
12/10/2018 Teshale.G 113
Overhead Allocation Using Activity
Based Costing (ABC)
Estimated Cost Driver Level
Cost driver 14inch 21inch Total
Number of setups 500 500 1,000
No of inspections 250 350 600
Packaging hours 1,200 1,300 2,500
Other (labor hours ) 14,000 16,000 30,000

12/10/2018 Teshale.G 114


Activity
Cost Pool Driver
Driver level Cost Cost rate

Number of 1,000 $100,000 $100,000/1,000 $100 per


setups setup

Number of 600 $90,000 $90,000/ 600 $150 per


inspections inspection

Packaging 2,500 $65,000 $65,000/2,500 $26 per


hours packaging
hr
Labor 30,000 $45,000 $45,000/30,000 $1.5. per
hours labour hr
12/10/2018 Teshale.G 115
Overhead Allocation Using Activity
Based Costing (ABC)
Application of Manufacturing Overhead Costs to
Products
How do we apply manufacturing overhead costs to
products?
Applying the manufacturing overhead to the
products involves:
– the activity pool rate is multiplied by the actual cost
driver used by the products.

12/10/2018 Teshale.G 116


14 inch
Activity Activity cost Cost Driver level Cost applied
pool rate
Set up $100 per set up 500 set ups
$50,000
Packing $26 per 1,200 packing
packing hour hour $31,200
Inspection $150 per Ins 250 inspections $37,500

Others $1.5 per labor 14,000 labor hrs $21,000


hour

Total $139,700
Number of units 5,000

12/10/2018
Manufacturing overhead
Teshale.G
cost per $28 117
unit
21 inch
Activity Activity cost Cost Driver level Cost
pool rate applied
Set up $100 per set up *500 set ups $50,000
Inspection $150 per Ins 350 inspections $52,500

Packing $26 per *1,300 packing $33,800


packing hour hour
Others $1.5 per labor *16,000 labor $24,000
hour hour
Total $160,300
Number of units 4,000
Manufacturing overhead costs per $ 40.075
unit
12/10/2018 Teshale.G 118
Unit Product Costs

Product cost per unit:


14inch 21inch
Direct materials $ 70 $ 80
Direct labor 30 40
Manufacturing overhead 28 40
Product unit cost $128 $160

12/10/2018 Teshale.G 119


Allocation of Overhead Costs
(Cont…)
The unit product cost is $128 for 14-inch model and
$160 for the 21-inch model.
Management accountant presented the following
information for decision
Model
14-inch 21-inch
One manufacturing overhead $ 120 $170
Cost pool (traditional approach)
Product unit cost: ABC with
four activity pools $128 $ 160
Differences: Decrease (increase) $ (8) $ 10
12/10/2018 Teshale.G 120
Exercise-7
Sino-Afro Optics produces two types of eyeglasses – standard
and deluxe. Operational data for 2013 is provided below
items standard deluxe
unit direct material cost 900.00 1,200.00
unit direct labor cost 144.00 192.00
unit direct labor hour 0.60 0.80
estimated annual production units 70,000.00 10,000.00
The company has a traditional costing system in which
manufacturing overhead is applied to units based on direct
labor-hours. Data concerning manufacturing overhead and direct
labor-hours for 2013 appear below:
estimated total manufacturing overhead 290,000
estimated total direct labor hours 50,000

12/10/2018 Teshale.G 121


Exercise-7 …
Required:
1. Determine unit product costs of the Standard and Deluxe
products under the company’s traditional costing system.
2. The company is considering replacing its traditional costing
system with an activity-based costing system. Below is data
relevant to the activity-based costing system which has three
activity cost pools:
estimated expected activity
activity and activity measures
overhead cost standard deluxe total
supporting direct labor (direct labor hrs) Br.150,000 42,000 8,000 50,000
batch setups (setups) 60,000 50 200 250
safety testing (tests) 80,000 20 80 100
total manufacturing overhead cost Br.290,000

Determine unit product costs of Deluxe and Standard under the


activity-based costing system.
12/10/2018 Teshale.G 122
END !!!